A:

In 1715, France was essentially insolvent as a nation. Even though taxes were raised to extremely high levels, the hole that warfare had left in the French treasury was too deep. France began to default on its outstanding debt and the value of its gold and silver currency whipsawed as people feared for the future of the nation. France turned to John Law to solve its problems. Law was a Scottish exile – he killed a man in a sword duel – whose talents in both gambling and finance gave him great weight with the government.

Law thought it was the unpredictable supply of gold and silver that was slowing the economy rather than a true economic problem. By switching to paper, he reasoned, more currency could be issued and trade would speed up. He created a bank that took deposits in coin, but issued loans and withdrawals in paper. Law's bank built up its reserves through a stock issue and also made a good profit by handling the government's finance needs.

Law decided to expand by acquiring the Mississippi Company. The company held a government-backed monopoly over trading with French Louisiana. Under Law's influence, the company's charters grew to include tax collection and all trade outside of Europe. The stock price shot up and the amount of cash needed to buy Mississippi shares meant that more money had to be printed.

Unfortunately, people wanted gold and silver when they took profits. Law capped redemption in gold and silver to avoid depleting his reserves. This removed France's paper currency from the gold and silver standard and put it on the Mississippi Company share price standard. The amount of paper currency afloat was now many times the actual reserves of gold and silver and hyperinflation set in.

Realizing the share price was vastly overestimating the wealth of beaver hides and gold in the French colonies, Law attempted a controlled slowdown. He depreciated the currency and the shares by half, but the decision triggered a selling frenzy that drove the share price down sharply. The paper currency became worthless and Law found himself in exile all over again. Since it occurred in the same year as the South Seas bubble, the Mississippi bubble is often confused with its British counterpart. The Mississippi bubble is actually more of a currency blunder than a true speculative bubble. (To learn more, read our feature Market Crashes: What are Crashes and Bubbles?)

This question was answered by Andrew Beattie.

RELATED FAQS
  1. What is the gold standard?

    The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold, but ... Read Answer >>
  2. What was the Gold Reserve Act?

    The Gold Reserve Act of 1934 gave the government the power to peg the value of the dollar to gold and adjust it as it pleased. ... Read Answer >>
Related Articles
  1. Investing

    Why Gold Is No Longer the Currency King

    Although a gold standard seems like a good idea, looking at its role in U.S. history reveals that it may not be the beacon of stability that it claims.
  2. Investing

    Why Gold and Silver Prices are Diverging (GLD, SLV)

    Gold and silver prices are seeing a big performance divergence in 2016. Here's why.
  3. Investing

    The Midas Touch For Gold Investors

    Find some golden opportunities by investing in gold commodities or futures contracts.
  4. Investing

    How Gold Affects Currencies

    There is a strong correlation between gold's value and the strength of currencies trading on foreign exchanges.
  5. Investing

    How Much Disaster Can Gold Hedge?

    Gold holds up well in the face of fear, but offers little in times of true collapse.
  6. Investing

    Is Silver The New Gold?

    With silver on the move, gold could quickly become yesterday's news.
  7. Investing

    8 Reasons To Own Gold

    This precious metal's rich history stems from its ability to maintain value over the long term.
  8. Investing

    How Safe Are Gold And Silver Investments?

    Contrary to both tradition and popular opinion, gold and silver may not be the best hedges against inflation nor the safest of havens.
  9. Insights

    Five Of The Largest Asset Bubbles In History

    The five bubbles discussed here were among the biggest in history; their lessons should be heeded.
RELATED TERMS
  1. Mississippi Company

    An example of a famous speculative bubble that occurred from ...
  2. Gold Reserve Act Of 1934

    An act that took away title to all gold and gold certificates ...
  3. Bubble Company

    A company whose valuation greatly exceeds that suggested by its ...
  4. Bubble Theory

    A school of thought that believes that financial bubbles (assets ...
  5. Silver Standard

    A monetary system in which a country's government allows its ...
  6. Mint Ratio

    1. The price of an ounce of gold divided by the price of an ounce ...
Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an ...
  3. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center